Oversimplify it for me: the correct order of investing

Question

I have been reading the top posts here, and the recommendations for what to invest in are often similar. What I'd like to know, in as simply of terms as possible, is what the consensus is on priority of these investments.

I am new to this, but here are some of the obvious options:

• Paying off credit card debt

• Paying off mortgage / student loans

• 401k up to employer match

• 401k past employer match

• IRA

• Emergency fund

• Other important investments that I have missed

Clearly this will vary person to person, but if you were asked to put an ordered recommendation on a highway billboard, what would it be?

(For example:

1. Pay off credit debt
2. Emergency fund for 6 months
3. 401k up to match
4. ... )

Answer 1

I am a firm believer in the idea of limiting debt as much as possible. I would not recommend borrowing money for anything other than a reasonably sized mortgage. As a result, my recommendations are going to be geared toward that goal.

The top priorities for me, then, would be to make sure, first, that we don't have to go further into debt, and second, that we eliminate the debt that we already have as soon as possible.

Here is how I would rate your list:

1. Putting together a small emergency fund

A small emergency fund, perhaps $1000 USD, is going to ensure that, while you are funding other things, you don't end up so cash poor that, if something unexpected and urgent comes up, you are forced to add to your credit card debt. Make this small fund your top priority, and it shouldn't take much more than a month or two to do it.

2. 401(k) up to the employer match

Getting out of debt is important, but if your employer hands out free money, you have to take it. It is just too good of a deal.

3. Paying off credit card debt / car loans / student loans / other consumer debt

Get rid of this debt as fast as possible. When you are done, you'll have more income available to you than you've ever had before.

4. Building up your emergency fund

Now that you have just gotten done eliminating your debt as fast as possible, don't stop there. Take the income you had been throwing at your debt, and build up your emergency fund to a few months' worth of your expenses. Finishing this fund up will enable you to withstand a small crisis without borrowing anything.

5. Retirement savings: 401(k), IRA, etc.

You are now in a very strong position financially, and can confidently invest. Deciding which type of retirement account is best for you depends on the details of your situation.

6. Paying off your mortgage early.

Once you are contributing a healthy amount to your retirement funds, you may want to consider paying off your mortgage early.

As I said before, I recommend getting down to the last step as quickly as possible. Depending on how much debt you actually have, if you sacrifice for a year or two you could be debt free and in a position to keep all of your investment gains. If you take your time paying off debt, like many people do, you could find yourself 10 years from now still making payments on your loans, still making car payments, and still needlessly sending interest to the banks, eating away at the gains you are making in your investments.

If you aren't committed to eliminating your debt quickly, and plan on having payments for a long time, then skip this advice and put retirement savings at the top.

Answer 2

• 401(k) up to matched amount
• High interest debt
• Emergency fund
• 401(k)/Roth 401(k) / IRA/Roth IRA
• Pay off student loans
• Pay off mortgage

One can generalize on Traditional vs Roth flavors of accounts, I suggest Roth for 15% money and going pretax to avoid 25% tax.

If the student loan is much over 4%, it may make sense to put it right after emergency fund.

For emergency fund priority - I'm assuming EF really requires 2 phases, the $2500 broken transmission/root canal bill, and the lose your job, or need a new roof level bills. I'm in favor of doing what let's you sleep well. I'm also quick to point out that if you owe $2500 at 18%, yet have $2500 in your emergency fund, you're really throwing away $450 in interest each year. There's an ongoing debate of "credit card as emergency fund." No, I don't claim that your cards should be considered an emergency fund, per se, but I would prioritize knocking off the 18% debt as a high priority. Once that crazy interest debt is gone, fund the EF, and find a balance for savings and the next level EF, the 6-9mo of expenses one.

One can choose to fund a Roth IRA, but keep the asset out of retirement calculations. It's simply an emergency account returning tax free interest, and if never used, it eventually is retirement money. A Roth permits withdrawal of deposited funds with no tax or penalty, just tracking it each year. This actually rubs some people the wrong way as it sounds like tapping your retirement account for emergencies. For my purpose, it's a tax free emergency fund. Not retirement, unless and until you are saving so much in the 401(k) you need more tax favored retirement money. I wrote an article some time ago, the Roth Emergency Fund which went into a bit more detail.

Last - keep in mind, this is my opinion. I can intelligently argue my case, but at some point, it's up to the individual to do what feels right. Paying 18% debt off a bit slower, say 4 years instead of 3, in favor of funding the matched 401(k), to me, you run the numbers, watch the 401(k) balance grow by 2X your pretax deposits, and see that in year 3, your retirement account is jump-started and far, far more than your remaining 18% cards. Those who feel the opposite and wish to be debt free first are going to do what they want. And the truth is, if this lets you sleep better at night, I'm in favor of it.

Answer 3

Money is a tool.

• It helps you continuously give up that which you value least, and add that which you value most.
• It makes it easier to see the compounding effect of saving, investing, and "living on less than you earn".
• Often, the best investments you can make are in yourself, your family, and your children.
• The suggestions below are a mix of investing in yourself, and financial saving and investing. Before you can have money to invest, you have to be safe and have an income. Having reserves lets you make choices that increase your income. Benefiting from compound interest lets you relax and help others.

Here is an "oversimplified" order of investments:

1. Minimal kit to be able to sleep safely and soundly, clothe yourself and feed yourself, and get to and from work.
2. Establish the habit of only buying what you need, have room to store, and are willing to take good care of.
3. Establish the habit of only considering something to be a "savings" if you would have been willing to "pay full price".
4. Enough money in a checking account to be able to tide yourself over from paycheck to paycheck, without ever risking overdraft fees.
5. At this point, it often makes sense to obtain a no-annual fee, no-monthly fee credit card or other line of credit -- but limit your line of credit to about 25 times the amount you can pay off in a month without charging any more to the card.
6. Establish the habit of buying durable things. Consider buying the $5 item that will last for years, instead of the $1 item that needs to be replaced monthly. Of course, only do this if you can store and maintain the $5 item, and could have afforded (and would have chosen to buy) the $1 items.
7. Set up direct debit so that the minimum payment for all of your bills automatically comes out of your checking account. Make sure that your monthly income exceeds your monthly outgo, so that you never have overdraft fees.
8. Borrow The Millionaire Next Door from your library; read it and return it.
9. Enough savings to cover first month's rent and security deposit, plus deposits on utilities. In other words, be able to use your own money to get into a home.
10. A $1,000 emergency fund.
11. The basic tools of your trade; a reliable method of commuting to work (including basic liability insurance if driving a car); and books and/or cheap tuition to learn the skills for your next job.
12. Renter's Insurance. If you have dependents, a modest term life insurance policy. If you have a car, collision and theft insurance. If your employer offers it, disability insurance. An umbrella liability insurance policy.
13. Pay off any credit cards (and other debt) that charge more than 10% interest per year, if necessary by rolling over to a card or loan with a lower permanent rate. I avoid all credit card teaser rates -- I judge a credit deal by its regular rate, not its starter rate.
14. Enough equipment to keep yourself in good physical shape. For some people, this is a pair of walking shoes; for others, a bicycle or pair of roller blades. For some it is Charles Atlas' program of isotonic exercises; for others, dumbbells or a cable-based weight lifting machine.
15. Get a safe deposit box, or other safe way to store valuable papers.
16. An emergency fund with three months' after tax living expenses -- unless you are in the Medicaid trap that prohibits having more than $2,000 of liquid assets. If you are in that trap, try to find a way to get out of it.
17. Establish yourself as a person (or family): Make a respectable home, with an honest job, a worthy spouse, and a neighborhood in which you feel comfortable. If you are religious, join a church, and attend regularly. Make a will.
18. Update insurance and wills.
19. 401(k) up to employer match.
20. Pay off short-term debt and student loans.
21. Take out an unsecured personal line of credit from a bank, even if it means paying a modest annual fee. Avoid borrowing against the line of credit. An unsecured line of credit is very helpful when obtaining (or re-financing) a mortgage.
22. If you expect that you would be happy to (and able to afford to) live in the same place for at least ten years, and if the after-tax cost of buying a home (including likely repair costs, principal and interest on a 30-year fixed rate mortgage, taxes, insurance, and utilities) is less than 125% of the comparable cost of renting (including rent, renter's insurance, and utilities), buy a home.
23. Re-finance your mortgage if it is sufficiently profitable to do so. (How profitable? That is worthy of its own question.)
24. After-tax tax-deferred retirement savings (e.g. Roth IRA and/or Roth 401(k)).
25. When you have enough money saved in your retirement savings, consider investment options that provide long term growth with reduced exposure to bear markets. (Some of these options require large minimum balances.)
26. Pay off mortgage. (Possibly before, possibly after retirement.)

Answer 4

Organize your expenses in order of the rate of return, and pay them in that order. By far the highest rate of return on your list is:

• 401k up to employer match

Nowhere else are you going to see an immediate 100% return (or 50%, depending on the company's matching policy) on every dollar you allocate to this pot.

Second would probably be:

• Paying off credit card debt

Money that you do not allocate here will usually incur a 15%-29% penalty. Outside of large expenses like a home, education, or a reasonable car, you never want to pay to use your own money (and borrowed money is still yours, remember that someday you have to pay all of it back). Avoiding a negative rate of return (interest) can be just as beneficial as finding a high positive rate of return on an investment.

• Paying off student loans
• Emergency fund

Continue down the list determining what must be paid first, and what the highest rates are in the immediate future and the long run. Meanwhile, live within your means, and set aside a portion of your monthly income towards things like a rainy day fund (up to a level which is not touched when reached). Additional savings through work or your personal investments should not be neglected (money saved early and compounded is worth many times what a dollar saved down the road will gain) especially if you are young in your career.

Answer 5

Great questions -- the fact that you're thinking about it is what's most important.

I think a priority should be maximizing any employer match in your 401(k) because it's free money.

Second would be paying off high interest debt because it's a big expense.

Everything else is a matter of setting good financial habits so I think the order of importance will vary from person to person. (That's why I ordered the priorities the way I did: employer matching is the easiest way to get more income with no additional work, and paying down high-interest debt is the best way to lower your long-term expenses.)

After that, continue to maximize your income and savings, and be frugal with your expenses. Avoid debt. Take a vacation once in a while, too!

Answer 6

All of the provided advice is great, but a slightly different viewpoint on debt is worth mentioning. Here are the areas that you should concentrate your efforts and the (rough) order you should proceed.

• Debt - Get out of debt..
• Budget - Live with a (reasonable) budget.
• Avoid trouble - Stay out of debt.
• Prioritize - determine your financial goals
• Save - learn to save and make your money work for you.
• Grow - Stay out of debt, Grow your wealth.

Much of the following is predicated upon your having a situation where you need to get out of debt, and learn to better budget and control your spending. You may already have accomplished some of these steps, or you may prioritize differently.

1. Save a small emergency fund (example: $1000)
2. Pay off debt including credit card debt, personal loans, student loans
3. Live within your means - avoid having a too large car loan (>10% income).
4. Save larger emergency fund (3-6 months expenses)
5. Pay off of your car loan (many people have a car loan).

Many people advise prioritizing contributing to a 401(k) savings plan. But with the assumption that you need advise because you have debt trouble, you are probably paying absurd interest rates, and any savings you might have will be earning much lower rates than you are paying on consumer debt. If you are already contributing, continue the plan. But remember, you are looking for advice because your financial situation is in trouble, so you need to put out the fire (your present problem), and learn how to manage your money and plan for the future.

Compose a budget, comprised of the following three areas (the exact percentages are fungible, fit them to your circumstances). Here is where planning can get fun, when you have freed yourself from debt, and you can make choices that resonate with your individual goals.

• Essential living expenses (<50-60%) (rent, food, utilities, transportation)
• Financial priorities (>20-30%) (debt, savings)
• Lifestyle (<20-30%) (cable, cell, entertainment, toys)

Once you have "put out the fire" of debt, then you should do two things at the same time.

• Learn to save and how to invest (make your money work for you)
• Save for your future (retirement, independence)

As you pay off debt (and avoid further debt), you will find that saving for both independence and retirement become easier. The average American household may have $8000+ credit card debt, and at 20-30%, the interest payments are $150-200/month, and the average car payment is nearly $500/month. Eliminate debt and you will have $500-800/month that you can comfortably allocate towards retirement.

But you also need to learn (educate yourself) how to invest your money to grow your money, and earn income from your savings. This is an area where many struggle, because we are taught to save, but we are not taught how to invest, choose investments wisely and carefully, and how to decide our goals. Investing needs to be addressed separately, but you need to learn how.

Live in an affordable house, and pay off your mortgage. Consider that the payment on a mortgage on even a modest $200K house is over $1000/month. Combine saving the money you would have paid towards a mortgage payment with the money you would have paid towards credit card debt or a car loan. Saving becomes easy when you are freed from these large debts.

Answer 7

It isn't always clear cut that you should pay off a debt at all, particularly a mortgage. In simple terms, if you are making a better return than what the bank is charging you, and the investment meets your risk criteria, then you should not pay back the debt.

In the UK for example, mortgage rates are currently quite low. Around 2.5 - 3% is typical at the moment. On the other hand, you might reasonably expect a long run average return of around 9 - 11% on property (3 - 5% rental yield, and the rest on capital gains).

To make the decision properly you need take into account the following:

• Expected average interest rate for the remaining duration of the mortgage.
• Expected return on whatever investment you would make with the money that you don't pay back to the bank.
• Expected inflation. Inflation is great for debt because the amount you owe remains the same in nominal terms but decreases in real terms.
• The perceived risk, and your tolerance for that risk. This includes potential interest rate changes, the riskiness of your investments, and inability to maintain interest repayments where your investment income is insufficient by itself (e.g. due to job loss, interest rate rise, investment income drop).

Answer 8

• Apart from all the things already mentioned here, be an avid spectator. This will help you in the analysis and market behavior without actually investing the money. You can learn necessary experience without actually paying for it.
• If you have expertise in any field. Use that experience to make investment decisions. Just know that being familiar with a company product is usually different than the financial dynamics as a whole.
• When you're buying or selling a stock, be particular about price. but don't let the daily fluctuations concern you too much.